This invention relates generally to financial services and products, and more particularly to financial systems that enable an exchange traded product (ETP) based on physical commodities or materials that are not stored in lots of uniform size and shape, and/or are not readily divisible or accessible/tradable in the quantities that may be desired in the marketplace. In particular, embodiments of the invention are described in connection with an ETP that holds base or bulky metals, but embodiments of the invention may be applied to other types of funds or products.
Unlike with certain precious metals such as gold or silver, many base metals such as copper and aluminum are traded and stored in bulky weight denominations (e.g., 25,000 kg). This creates problems for the creation and redemption of ETP shares based on these metals, since the bulky size results in a mismatch of weight transferred for a fixed number of ETP shares. For example, when an authorized participant (AP) wants to create new shares of an ETP based on physical gold owned by the ETP, the AP delivers an amount of gold exactly equal to the value of the ETP shares to be created in exchange for shares of the ETP. This is because gold can be traded in unallocated amounts in addition to full bars of gold such that the AP can trade gold bars up to the closest value of the ETP shares and the remaining amount to equal to the ETP shares in unallocated form. In contrast, base metals are traded in bulky sized lots with a permitted level of deviation in the final delivered amount, hence the AP usually cannot deliver a precise amount of the base metal that corresponds to the value to create a standard lot (i.e., a fixed number) of ETP shares, thus causing a mismatch in the economic value transferred. Base metals do not have an equivalent means of trading in unallocated amounts that are available to precious metals such as gold and silver.
In many cases, it may be undesirable to offset the mismatch using simple cash transfers between the ETP and the AP. Cash transfers might be avoided by entering into contractual arrangements between each AP and the ETP, but this could result in the ETP owning a portion of a large number of individual lots of bulky metal (or any other asset not readily divisible), thereby increasing the ETP's exposure to risk, holding large cash positions that are not backed by the physical metal desired by the ETP for purposes of its investment strategy or generally causing under or over exposure to the physical metal in relation to the value of the ETP shares delivered/redeemed by the ETP. This would also make operation of the ETP complex and inefficient, thereby reducing its market competitiveness or ability to meet its investment purpose. There is therefore a need in the market for a method by which the difference in value between an amount of an indivisible commodity and corresponding ETP shares can be compensated for in the creation and redemption processes for the ETP.